Payroll best practices are about reducing administrative burden, while at the same time increasing accuracy and compliance. Since there are such wide variances in vacation practices, it’s worth trying to shed some light on how these practices may be improved.

Many employers provide vacation pay each period, on that period’s vacationable earnings. By contrast, other employers accrue vacation time and/or pay. There are also wide differences in how employees take annual vacations. Where employers accrue vacation pay, this is sometimes paid out as a lump-sum once a year or cashed-out, without taking time, particularly on termination. Other employees reduce vacation pay accruals, using current hourly rates for the time taken.

Given these differences in how vacations are treated, what are the best practices employers should strive for in order to simplify processing and ensure compliance?

The first point to make is that for employers of any size, vacation best practices require employee and manager self-service, supported by workflows that integrate with any scheduling, time and attendance, HR or payroll systems concerned.

In this regard, the best practice is a single, web-based self-service window through which employees can initiate vacation-related requests and managers can approve them. Workflows should route approved requests for vacation time to the applicable scheduling or time and attendance system. By contrast approved requests to cash-out vacation pay can be routed directly to payroll.

There are really 2 parallel employment standards requirements related to vacations. One is to give employees vacation time (expressed as calendar weeks away from work) and the other is to provide vacation pay (usually expressed as a percentage of vacationable earnings, i.e. 4 or 6%).

It’s a best practice for employers to accrue vacation time, as part of managing employee entitlements. Some employers accrue vacation time after each completed pay period, particularly where employees take vacation time in the year earned or during 1st year of service stub periods. Otherwise, employers are only required to recognize vacation time as owing when a full year of service has been completed.

Best practices for vacation pay depend on the type of employee involved.

For hourly-paid employees, the simplest and most compliant option is to pay vacation pay each pay period, on the earnings in that pay period. This eliminates any vacation pay accruals, as well as any separate payment of accrued vacation pay.

Where vacation pay is not given each pay period, best practices are about how this accrual is paid out. It’s common for employers to reduce accrued vacation pay using current hourly rates for the time taken. However, this practice will not be compliant in all circumstances, particularly where:

Employees work more than regular or scheduled hours in the applicable entitlement year. Forty hours per week, for 50 weeks, is 2,000 hours. Paid at 4%, this equals 80 hours. So long as hourly rates have not changed, paying employees at hourly rates for vacation time taken is compliant. However, if an employee has worked 2,100 vacationable hours, 4% would be 84 hours. Paying just for the vacation time taken, i.e. 80 hours, would not meet the minimum vacation pay requirements.

Vacation pay is itself vacationable. If an employee’s hourly rate is $15; 2,000 hours have been worked; and no other earnings are vacationable, the accrued vacation pay owing at 4% would be $1,200 or 80 hours. If vacation pay was itself vacationable, the accrued vacation pay owing in the next vacation year would be $1,248, i.e. the equivalent of 83.2 hours at $15. Providing 80 paid vacation hours at $15 would not comply with the minimum requirements.

In the applicable vacation year, employees have exception pay earnings, such as overtime, non-discretionary bonuses or sales commissions, which are vacationable. If an employee had a $5,000 vacationable bonus, in the vacation year when vacationable earnings were otherwise 2,000 hours at $15/hour, the vacation pay required at 4% would be $1,400. Paying 80 hours at $15 would only be $1,200, so the minimum requirement would not be met.

Where employees are paid accrued vacation pay at regular hourly rates for vacation time taken, to ensure compliance, employers will have to run reports comparing vacationable earnings versus the vacation pay given. Usually, this is the earnings in the prior vacation year against vacation pay in the current year. Where employees allow employees to take vacation time in the current year, i.e. the year the right is earned, this comparison would have to be based on that year (where vacation pay is a vacationable earning, include any vacation pay paid in those earnings).

I would argue that vacation pay best practices are not to accrue vacation pay, but to accrue raw vacationable earnings, applying the correct vacation pay percentage only when payment is made. The primary reason for this is that, in jurisdictions where an additional vacation week is required after completing, usually, 5 years of service, the rate of vacation pay owing is contingent – contingent on completing this 5th year. For example, in BC the earnings in an employee’s 5th year of service are the basis for the vacation pay owing after the 5th year has been completed. If an employee were to quit during this 5th year, only 4% is owing. After the 5th year is complete, vacation pay on these earnings is now owing at 6%. This means either adjusting the accrued vacation pay balance owing, on completion of the 5th year, or accruing at the higher rate and adjusting down to 4% if the employee leaves before the 5th year is completed. These steps can be avoided if vacationable earnings are accrued, rather than vacation pay.

Alan McEwen is a Vancouver Island-based HRIS/Payroll consultant and freelance writer with over 20 years’ experience in all aspects of the payroll industry. He can be reached atarmcewen@shaw.ca, (250) 228-5280 or visitwww.alanrmcewen.com for more information.

6 Responses to What are Vacation Time and Pay Best Practices?

Do you have any advice for a company switching from accrued vacation pay to paying it out on each cheque? We’re trying to streamline our accounting and payroll and eliminate the liability of accrued vacation pay, but worry it might seem like we’re ‘cheaping out’ to our hourly employees who have become accustomed to having an accrual. Any suggestions on how to bring this up?

You can sell it to them by suggesting they set up automatic transfers on payday to a separate account so they have access to it when they want it (for a rainy day). Puts the employee in control of their money. If you offer direct deposit, you may be able to split out a portion of it to a separate account for them. We’re in the middle of doing the same thing, so are also thinking about this! Don’t forget to check the provincial legislation surrounding the ability to do this. We are only offering to new employees at this point – will need to sell it to the existing employees as we cannot force them into it.

One other factor you need to consider is the potential impact on EI eligibility. If an employee works 50 weeks in a year, and takes a 2 weeks paid vacation, for ROE purposes there are insurable hours in 52 weeks (i.e. 40*52 or 2,080). By contrast, if an employee works 50 weeks, is paid vacation pay on every direct deposit, any vacation time taken is unpaid (i.e 40*50 or 2,000). The difference might not sound like much, but the rules around EI eligibility are very strict. If an employee needs 600 hours to qualify for maternity/parental leave and only has 599, too bad. For permanent, full-time employees, the impact of paying vacation pay every period may not be very great, but the impact increases as working conditions become more casual or on call.

In regards to paying out vacation pay with each cheque, can you please clarify the requirements in regards to accruing/recording of vacation time? For example, in the following paragraph, “For hourly-paid employees, the simplest and most compliant option is to pay vacation pay each pay period, on the earnings in that pay period. This eliminates any accruals, as well as any separate payment of accrued vacation pay.”, does eliminate any accruals reflect both time and pay, or just the pay?